Economists React: China’s Rock-Bottom Inflation

Readings on Chinese inflation came in below expectations Friday, with the consumer price index up just 1.8% on-year in April versus economist expectations of 2.0%. The producer price index, which reflects prices for finished goods at the factory gate, fell for the 26th straight month, down 2.0% from a year earlier.

Low inflation is especially striking considering that China is still a fast-growing economy. If prices grow more slowly than expected, that can hammer corporate profits and make debt burdens harder to bear.

Some analysts are starting to think the time has come to ease monetary policy –though that risks aggravating already worrying levels of borrowing.

Economists jump in (slightly edited for style):

–Low inflation is both bad news and good news for markets. It’s bad news (especially the 2.0% fall in PPI inflation) because the too-low inflation readings reflect the weakness of aggregate demand, including both consumption and investment demand… It’s good news because low inflation gives the People’s Bank of China room for maintaining low interbank rates and engineering some yuan depreciation. It also gives the PBOC room to ensure stable credit growth. For the government, it can carry out its mini-stimulus by speeding up fiscal spending to boost aggregate demand. – Ting Lu and Xiaojia Zhi, Bank of America Merrill Lynch

–Both CPI and PPI came in lower than expected, showing the pace of demand recovery remains mild. Looking ahead, we expect CPI to rebound in coming months…. PPI is likely to follow the same trend of CPI in the near term, given rising input prices…. Though we believe the monetary authority will hold its prudent stance in the medium term, as it mentioned in the monetary policy report for the first quarter, we do not rule out the possibility that the authority will implement more targeted easing measures for selective areas, such as rural development projects, support for small and medium-sized enterprises and shanty-town renovation projects. – Fan Zhang, CIMB

–Producer prices actually declined by 0.2 month-over-month, in contrast to rising international commodity prices, indicating PPI deflation can be mostly attributed to domestic factors. Generally higher international commodity prices, together with a positive contribution from base effects in the next few months, will likely ease PPI deflation further by July. But in the absence of a major policy stimulus, PPI deflation may last throughout the year. – Shuang Ding, Citigroup

–Both Europe and China face the risk of deflation if economic performance disappoints; however, it would be a much greater problem for Europe. Deflation is less of an issue when growth is relatively rapid, as China has showed in the past… If inflation falls from the current 1.8% pace, the PBOC has plenty of room to cut nominal interest rates… China’s problem is excessive investment due to artificially cheap borrowing costs. – Richard Jerram, Bank of Singapore

–The key question here is: as growth momentum remains soft and inflation stays low in the near term, will the central bank choose to ease monetary policy? In economic theory the answer could be yes, but this is unlikely to happen in practice. The recently published PBOC Monetary Policy Operation Report reiterated that it will maintain the current monetary policy stance. Concerns about the efficiency of monetary policy transmission and financial stability issues seem to have dominated in monetary policy consideration: The worry is that monetary easing could cause credit to flow to high-risk borrowers (real estate, local-government financing platforms, manufacturers in overcapacity industries), as has happened in the past. – Haibin Zhu, J.P. Morgan

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